Why I'm Not Buying Duolingo Stock (Yet)

Parkev analyzes Duolingo's stock, focusing on its strategic response to the threat of artificial intelligence. Parkev highlights that Duolingo's management has decided to prioritize customer acquisition, even at the expense of short-term monetization. This strategy involves offering more freemium features to attract users into its ecosystem, with a long-term goal of reaching 100 million daily active users. While this approach is expected to boost customer retention and user growth, Parkev notes it will likely come at a cost to profitability in the near term.

Parkev observes Duolingo's impressive financial trajectory, with revenue soaring from approximately $100 million in 2020 to over $1.15 billion in the last 12 months. The company also significantly improved its operating margins, moving from -30% in 2022 to 14.2%, a trend Parkev attributes to widespread cost-cutting efforts across tech companies during fears of a 2022 recession. However, Parkev cautions that the new strategy, focusing on user growth over immediate monetization, could lead to a stabilization or even a decline in Duolingo's margins and a continued decrease in its return on invested capital (ROIC) from its recent peak of nearly 40% to 30%, although this 30% figure still significantly surpasses its weighted average cost of capital. Parkev believes any short-term decline in ROIC would be temporary if the company successfully achieves its user acquisition targets.

Regarding valuation, Parkev notes that Duolingo's stock has rebounded significantly from its April low of $89 to its current price of $143. Despite this recovery, Parkev finds the stock's valuation, particularly its forward P/E of 19, to be still near its lowest levels in recent years, suggesting it might be slightly undervalued. Parkev's updated discounted cash flow (DCF) analysis, which accounts for lower estimated risk, sets the fair value at $149. Given the current market price of $143, Parkev considers Duolingo to be fair to slightly undervalued. However, due to the increased risks associated with the company's new strategy and the competitive landscape with AI, Parkev prefers to apply a larger margin of safety and would wait for a better entry price before buying Duolingo stock.